Thursday, June 03, 2004

Monetary Policy Edition: Wow, NYT Takes on Fed

One reason the Fed's go-slow approach is wrongheaded, Mr. Paulsen said, is that in 1994, when policy makers raised rates, they were starting from a much higher base. Short-term yields were around 3 percent and long-term yields were roughly double that level when the Fed started the rate increases. Now, with rates in the basement, the Fed could raise them two percentage points before any effect would be felt in the economy, Mr. Paulsen argued.

How high will bondholders take yields with the Fed in slow motion? Mr. Paulsen reckons that the 10-year Treasury could rise to 6 percent this year and maybe hit 7 percent later on a wild spike.

Compounding the problem, according to Paul Kasriel, director of economic research at Northern Trust in Chicago, is the Federal Reserve's willingness to keep the money-supply spigots wide open. Although the money supply contracted in the final quarter last year, he said, in the past 13 weeks, the broad measure of money supply known as M2 is up 12 percent, annualized.

"It seems as though Mr. Greenspan thinks there is nothing that printing money won't solve," Mr. Kasriel said. "If printing money created real wealth, then Zimbabwe would be one of the richest countries on the face of the earth. My thesis is we have really not paid the price for the excesses of the late 1990's."

One of the excesses that looms large right now is the debt load shouldered by the American consumer. As Mr. Paulsen pointed out, consumers have continued to increase their leverage in the past 20 years even as others - including the industrial sector, third-world economies, the telecommunication industry, Asian countries - have reduced their debt at various times.

"If you raise mortgage rates two and a half points from their lows, we're going to find out the consumer is overindebted," Mr. Paulsen said. "And suddenly, the whole issue of consumer weakness comes back."

The real stress test for the economy, in Mr. Kasriel's view, will come when the Fed limits credit growth. He thinks that's where we are now.

Mr. Kasriel expects economic growth to slow in the second half of 2004; a year from now, however, he says things will become very difficult. "That's when I think we could see the dollar go into a sharp decline, inflation spike up and the Fed maybe has no choice but to become more aggressive," he said.

"When rates start to rise, it changes the game," Mr. Kasriel said. "That's when we ultimately pay the price for our excesses."[empasis added]

This story confirms the previous Money Policy Edition post I made, that monetary supply is running at a breakneck speed. The previous author's proposal was that this was because the Fed was preparing for some crisis. The alternative is that Greenspan is attempting to inflate the American economy as much as possible for a preparation for interest rate rises. In any case, it's all pretty dodgy policy. There is some major back-room dealing going on here and the whole story has definitely not come out. Either the American economy is much more fragile than the official numbers say they are and Greenspan is covering up for it with this monetary surge, or we're about to enter a hyperinflation scenario, or the Fed is anticipating a major market shock/crisis with this surge in order to try to head any systemic risk before it happens. One thing that it does not auger is that all is well no matter how cheery the public faces are!